The prospect of parts of the United States government shutting down could come as a relief to the Reserve Bank of Australia if it leads to a further sell-off in the local currency.

The RBA board, which is due to meet on Tuesday, is faced with a dilemma of trying to balance a potential housing bubble with the advantages of lower rates, which help to spur domestic activity and add pressure on the Australian dollar. “If there is a legitimate concern about the US government defaulting on a payment then that is a serious issue and a US-dollar positive," ANZ Banking Group currency strategist
Andrew Salter
said.

He is forecasting the Australian dollar will fall to US90¢ by the end of this year and US85¢ by the end of 2014.

The RBA has lowered rates to 2.5 per cent in the hope of spurring domestic demand and pushing the currency lower. Some of the RBA’s frustrations could be eased if the current US political dramas over spending and breaching existing debt limits boost demand for US dollars. “It tends to make the US dollar stronger," UBS interest rate strategist
Matthew Johnson
said.

AFR
AFR

“More volatility tends to encourage people towards the things that are more liquid, so US treasuries and the US dollar get stronger," he said.

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A partial possible shutdown of the US government could occur this week, as a standoff between Republicans and President Barack Obama plays out over a move to delay healthcare reforms.

The deadlock is tied to funding measures which could close non-essential public services last shut down in 1996. Public services in the US were shut down 17 times between 1977 and 1996.

Tapering ever-more unlikely

The Australian dollar was trading around US93.15¢ on Friday – nearly 12 per cent lower than its $US1.05 highs reached earlier in the year.

The currency has been under pressure since April as a result of expectations of stronger growth in the US and the prospect of the US Federal Reserve tapering its $US85 billion ($91.2 billion) monthly bond-buying program.

Mr Salter said if the Fed’s tapering plans are delayed as a result of the US’s debt ceiling dramas, “it is actually US-dollar negative, which potentially pushes up the Australian dollar."

The local sharemarket is pricing in a slim 6 per cent chance that the RBA will keep rates at an historically low 2.5 per cent when the board meets on Tuesday. Despite this, some economists believe the RBA should make another cut.

“If I was on the board I would probably have rates already at 2 per cent," Mr Johnson said. “I do think they should act – the unemployment rate is going up and inflation is at the bottom of the RBA’s target band. That is an environment where monetary policy can be eased safely. The RBA may not cut because of the housing market, but I think talk of a bubble is premature."

HSBC chief economist
Paul Bloxham
thinks the RBA will hold given that heat is emerging in the local housing market and because of uncertainty surrounding political events in the US.

"We saw a similar event over the raising of the US debt ceiling in August 2011 . . . the RBA ended up not raising [local rates] because they were concerned about offshore developments," he said. “What happens on Tuesday is only the first step. The most important aspect will be how they negotiate on lifting the debt ceiling. The most likely outcome will be deferring the discussion and temporarily lifting the ceiling."

There are concerns that if US government spending is trimmed following a forced shutdown, fourth-quarter economic growth could be cut by 1.4 per cent, according to Bloomberg. This could result in the US Federal Reserve further delaying the tapering of its bond-buying program until early 2014.

“The October 29-30 meeting will be too close to the debt ceiling debate in the US Congress, while the Federal Reserve is likely to have to further reduce its growth forecasts for 2013 and 2014 in December. [These are] hardly backdrops for the beginning of a tapering process," Westpac chief economist
Bill Evans
said in a note to clients.